It o Integral and It o - Doeblin Formula Stochastic Differential Equations
It o Integral and It o - Doeblin Formula Stochastic Differential Equations
It o Integral and It o - Doeblin Formula Stochastic Differential Equations
January 3, 2021
In the following exercises {Bt }t≥0 is a standard Brownian motion process with filtration (Ft )t≥0 .
2. The integral Z t
It = Bs ds
0
is not a stochastic integral although they are random variable. For each w, the integrand is nice continuous
functions of s and the integration ds is just traditional (Riemann) calculus integration. Find expectation
E(It ) and variance V ar(It ).
Hint Show that Z t Z t
sdBs = tBt − Bs ds.
0 0
Rt
and using martingale and isometry properties of Itô integral 0
sdBs .
3. Find dBt3 and dBt2 .
4. Prove that
5. (Optional) Let
βk (t) = E(Btk ).
(a) Find dBtk
(b) Prove that
Z t
1
βk (t) = k(k − 1) βk−2 (s)ds
2 0
6. Let Rt
µ(s)ds− 12 σ 2 t+σBt .
St = S0 e 0
Find dSt .
1
7. Assume that dSt = µSt dt + σSt dBt . Compute
(a) d(2St )
(b) d(Stn )
Rt
θs dBs − 21 θs2 ds
8. (Exponential martingale) Let Zt = e 0
2 SDEs
1. Solve the SDE
dXt = 5dt + 2dBt , X0 = 1
to find the distribution of X1 .
2. Suppose that the process (Xt )t≥0 is governed by the geometric Brownian motion:
5. Suppose that the process (Xt )t≥0 is governed by the Ornstein-Uhlenbeck process:
Find the conditional distribution of the random variable (X7 |X3 = 4).
Hint: consider Yt = 4 − Xt
6. (Solving the Vasicek equation). The Vasicek interest rate is driven by the stochastic differential equation
where α, β, σ are positive constant. This exercise shows how to derive this solution. Solve this SDE by 2
approaches
Approach 1 Matching method
Approach 2 i. Apply Itô - Doeblin formula to compute d(eβt R(t)).
ii. Integrate the equation you obtained in a) to solve for Rt .
7. (Solving CIR equation) The Cox - Ingersoll - Ross interest rate is given by
p
dRt = (α − βRt )dt + Rt σdBt ,
where α, β, σ are positive constant. Although there is no closed - form solution for CIR model but we can
determine the distribution of Rt for each given positive t
2
(a) Apply Itô - Doeblin formula to compute d(eβt R(t)) to show that
Z t
α βt p
eβt Rt = R0 + (e − 1) + σ eβu Ru dBu
β 0
iii. Take expectation both sides to derive E(Xt2 ) and then E(Rt2 ).
iv. Compute V ar(Rt )
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